Jun 18, 2010

Perhaps this question is one of the most relevant questions in Risk Management and the Actuarial profession. It's a key question that should be discussed on Board Level in every (financial) area.

Also this question is relevant in setting up and managing complex projects like Solvency II, ERM, Pension Fund Risk Management, ALM and even "In control" projects.

The answer
Now let's try to answer this intriguing question

Managers are experts in 'decision taking'. Modelers are experts in reducing and simplifying complexity to decidable parameters.

Now the Quality (Q) of a management decision (D) is defined by the equation:

[ Q(D)= Q(Manager) x Q(Modeler) ],

where Modelers are responsible for the Quality of the Input (data) of the model [Q(Input Model)] and the Quality of the modeling process itself [Q(Modeling)].

More refined, we may therefore define :

Q(D)= Q(Manager) x Q(Input Model) x Q(Modeling)

Luckily, not all Q's are independent!
Both Managers and Modelers can raise the Quality of the outcome of the Decision process by asking each other "What If" questions.

By asking WI-questions with regard to the 'Input of the Model" [Q(Input) = data, decision parameters] and examining the output, Modelers are able to raise the Quality of their (technical) Modeling by improving their technical Model [Q(Modeling)].

Moreover, decision parameters are not set in stone. So by asking WI-questions, Modelers become more aware of the Management Decision Consequences (MDCs), helping them to develop and simplify decision parameters to the most adequate, understandable and possible simplified form. Or as Albert Einstein quoted it:

"Everything should be made as simple as possible, but not simpler"

On the other hand, by asking WI-questions, Managers can study the effects of various decisions they might take in different (simulated future) circumstances (as roughly described by the Manager).

This process improves the decision taking skills of a Manager and therefore improves the Quality of the Decisions taken by Managers [Q(D)] in general. At the same time, the Modeler may use the given information from the Manager to improve his Model and (future) data as well.

Conclusion
We may conclude that the answer to the question 'What managers, who are not modelers, need to know about models' is:

Nothing, as long as Manager and Modeler intensively communicate with each other, ask WI-questions, are not afraid to admit their weakness or doubts, challenge each other and don't manipulate each other!

Aftermath What happens when communication between Managers and modelers fails, is well illustrated in the Gulf of Mexico Oil Disaster, where BP CEO Tony Hayward stated before congress:
- “I simply wasn’t involved in the decision-making.”
- “Clearly an engineering judgment was taken.”

It's easy to spot failing Management-Modeler relationships by means of the next 'Management-Modeler Symptoms Matrix'.....

If you happen to be a modeler in the upper left quadrant, get out as fast as you can!

Disclaimer

Maggid is an actuarial professional, and like every actuarial professional or human being, he makes mistakes. Maggid encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong.

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